Last month I wrote to you about the potential sea-change brewing in long-term interest rates. At the time I wrote, “Is this sea-change upon us today? Not yet … but the winds of change are stirring.”
Those winds of change have reached tropical storm levels in the past couple of weeks and are threatening to turn into an outright hurricane.
The key chart to keep a close eye on is this one – the chart of long-term Treasury Note yields, dating back to the Reagan presidency.
The trend lower in long-term interest rates is the trend to beat all trends. It’s been 30 years in the making … and the trend line is currently under attack as can be seen in the bottom right of the chart above.
I wouldn’t say that this trend is broken just yet. We’ve seen brief breaches of this trend before – most notably in 2007 – 2008. What we’re seeing today, however, is very serious.
The whole structure of modern finance today is built on an assumption of persistent low long-term interest rates. If long-term rates in the US rise dramatically, they will be the undoing of many a financial engineer.
In the past 5 months alone, yields on Treasury notes are up nearly a full percentage point from just under 1.4% to nearly 2.4%. That’s an increase of nearly 70%!
The damage already done to interest-rate sensitive instruments like utilities and REITs has been swift … and brutal.
Utilities have dropped almost 11% from their highs less than 5 months ago.
REITs are even worse. They’re now down an incredible 23% in less than 5 months.
Popular bond funds like the iShares 7 – 10 Year Treasury Bond fund (IEF) have blown through their SSI stop losses.
Existing income investors in such funds are in a tough spot because they locked in lower long-term yields and have seen their capital take a serious hit as long-term yields moved higher.
On the other hand, investors who have been waiting for a good opportunity to add some income generating investments to their portfolios may be in luck. Current yields are much higher than what they were even a few weeks ago.
Is this a good time to lock in some higher yields while we can? It’s an interesting question … and it depends, of course, on your time horizon.
I’m personally not ready to start reaching for yield just yet … but I am closely monitoring the situation.
I’d say that we live in interest-ing times!
Richard M. Smith, PhD
CEO & Founder, TradeStops